David Ging, Treasury strategist at Donaldson, Lufkin & Jenrette, believes the market will edge higher regardless of the meeting's outcome. In fact, with Y2K expected to keep the Fed sidelined for the remainder of the year, the market may finally be able to breathe a sigh of relief.

A rate hike is expected to be digested without much of a problem because the market believes it will be accompanied by a dovish statement from the Fed indicating that upside risks in the U.S. economy have been reduced. But Palma said the risk is that the market gets a Fed tightening alongside a hawkish Fed statement.

"The market isn't prepared for that possibility," Palma said.

Meanwhile, Fed Chair Alan Greenspan's speech before the American Council of Life Insurance Monday morning centered on bank reform and did not mention monetary policy. See full story.

Josh Feinman, chief economist at Deutsche Asset Management Americas, said he doesn't see a lot of value in U.S. Treasurys with the 30-year's yield close to 6 percent. The risk going forward, he noted, is that the market will witness more Fed tightenings.

The 10-year added 2/32 to yield
TNX, +0.41%
5.913 percent. The 5-year rose 1/32 to yield 5.838 percent. The 2-year edged up 1/32 to yield 5.753 percent. The discount rate on the 52-week bill was up 1 basis point at 5.21 percent. In the futures pit, the December Treasury bond contract shed 1/32 to 114-29.

Trading was listless throughout the session, with players unwilling to take positions ahead of the Fed meeting.

Mike McInerney, vice president of futures trading at Commerz Futures, said most of activity early in the session was concentrated in the 10-year sector, with central banks -- mostly European -- on both sides of the trade.

In the commodity arena, the Bridge/CRB index rose 1.03 to 206.66 while December crude neared 3-year highs, adding 22 cents to $25.13. See latest commodity prices.

Fed focus

A good deal of Tuesday's attention will center on the statement accompanying the Fed's decision on rates.

"Even if the Fed does raise the fed funds rate by 25 basis points, bond prices should not be harmed much. That's because recently still well-contained unit labor cost growth means that any tightening would be viewed as the Fed being 'ahead of the curve' in containing broad-based inflation pressures," said Maury Harris, chief economist at PaineWebber.

Harris believes the Fed will leave rates unchanged and maintain a tightening bias. The bias to tighten could be qualified as a "curve ball" as it would prolong bond market uncertainty about the Fed and thus prevent any potentially re-stimulative drop in bond rates.

Though bonds are more prepared for a Fed rate hike, the market won't be surprised if the central bank stands pat, according to John Lonski, chief economist at Moody's Investors Service.

Lonski believes that leaving rates unchanged will pose greater risks as it will keep consumer demand strong and could trigger a buying spree in the stock market.

Curve plays

The yield curve remained rangebound in anticipation of Tuesday's Fed news. The spread between the yield on the 30-year bond and 2-year note inched up to 27.1 basis points from 26.0 basis points at the previous close as short issues outperformed after trailing significantly over the past weeks on uncertainty regarding the Fed's next move. And the spread between the yield on a 10-year note and 30-year bond stood at 11.1 basis points from 10.9 basis points on Friday as the 30-year lagged.

Ging said a steepening trade is more likely to occur following the Fed's announcement on rates Tuesday as the curve has already flattened so much in recent weeks.

In economic news Monday, September business inventories rose by an as-expected 0.4 percent, the heftiest increase since March. In addition, the Atlanta Fed index for October edged up to 13.7 from September's 11.1. Within the index, the prices paid component fell to 16.2 from September's 27.0 while the new orders sub-component came in at 13.4 from the previous 17.1.

Looking ahead, October industrial production and capacity utilization will be out Tuesday. A survey conducted by CBS MarketWatch.com predicts a 0.3 percent rise in production with a utilization rate at 80.3 percent. In addition, the weekly retail sales reports from LJR Redbook and BTM Schroder will be released. See and .

In the currency market, the dollar traded a smidgen lower against the yen and the euro.

Dollar/yen was recently changing hands at 104.82, off 0.2 percent from the previous close. The euro, meanwhile, rose 0.1 percent against the greenback to 1.03290. See latest currency rates.

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